Entrevista a Catherine Yeung, Investment Director na Fidelity International sobre a situação na China.
Key Messages:
- The market reaction has been overstated.
- This type of regulatory intervention is neither new nor a significant departure from its historical trajectory.
- It remains a pro-market, pro-business economy, focused on innovation and economic growth to achieve the goal of doubling its GDP per capita by 2035.
- Sectors such as technology, consumer goods and healthcare still have the same great potential in the medium and long term as in recent years.
Regulation
China´s Central Financial and Economic Affairs Commission recently stated its intention to pursue ‘common prosperity’ with a focus on rebalancing growth, addressing social inequality and a regulation reset. This has concerned markets that China will not be as business friendly as in the past. Do you think this is the case?
No, I think this is likely overstated. China wants to tackle social inequality and promote social mobility with five tools –redistribution, social welfare, taxes, charity and inclusive education– and one clear target: to increase the middle-income group's share of the economy.
Note that regulatory intervention in China is not new and recent actions are not a significant departure from its historical trajectory. China has made substantial progress towards reforming its markets and aligning them with international standards over the past decade. Economic progress has been at the forefront of policymaking for much longer and there’s nothing to suggest that has changed. And indeed, the Politburo recently emphasised that China is still a market driven economy, promised more transparent communication and pledged support for small and medium enterprises.
No, I think this is likely overstated. China wants to tackle social inequality and promote social mobility with five tools –redistribution, social welfare, taxes, charity and inclusive education– and one clear target: to increase the middle-income group's share of the economy.
Note that regulatory intervention in China is not new and recent actions are not a significant departure from its historical trajectory. China has made substantial progress towards reforming its markets and aligning them with international standards over the past decade. Economic progress has been at the forefront of policymaking for much longer and there’s nothing to suggest that has changed. And indeed, the Politburo recently emphasised that China is still a market driven economy, promised more transparent communication and pledged support for small and medium enterprises.
This heavy regulation in the last few months has addressed many tech-companies, including online-education ones. Didi had to stop offering its app to new customers. Tencent had to temporarily stop new registrations for WeChat. Why the clamp-down by the Chinese cyberspace authority?
Industries such as mobile payment providers, consumer finance and e-commerce names have been targeted by regulatory changes relating mostly to antitrust and data security issues. There is a particular sensitivity to overseas listings by data-heavy companies, as we have seen with the recent listings of Didi. This seems likely to drive many more companies back to listing on the mainland and Hong Kong. The thrust of the regulatory changes in the internet space has been around anti-trust and data security, policies which have been in the works for some time and in many ways have lagged other countries in terms of basic "infrastructure".
From a timing and historical perspective, it is not the first time we have witnessed heightened regulation in China. We only need to cast our minds back to 2018 when government halted new gaming licenses, which in turn saw a near 50% correction in Tencent’s stock price. Markets dislike uncertainty but we have since seen Tencent's shares rally (up 90% from these lows at the end of July 2021) post the clarification of these "rules".
Industries such as mobile payment providers, consumer finance and e-commerce names have been targeted by regulatory changes relating mostly to antitrust and data security issues. There is a particular sensitivity to overseas listings by data-heavy companies, as we have seen with the recent listings of Didi. This seems likely to drive many more companies back to listing on the mainland and Hong Kong. The thrust of the regulatory changes in the internet space has been around anti-trust and data security, policies which have been in the works for some time and in many ways have lagged other countries in terms of basic "infrastructure".
From a timing and historical perspective, it is not the first time we have witnessed heightened regulation in China. We only need to cast our minds back to 2018 when government halted new gaming licenses, which in turn saw a near 50% correction in Tencent’s stock price. Markets dislike uncertainty but we have since seen Tencent's shares rally (up 90% from these lows at the end of July 2021) post the clarification of these "rules".
Which sectors might be regulated next?
Besides the data security I just mentioned, policy focus is likely to be around areas to do with fairness (i.e. antitrust policies which could see some e-commerce players who have scale advantage to face scrutiny). The policy direction has been hinted towards these regulatory changes for some time now so many of the leading companies are complying.
Besides the data security I just mentioned, policy focus is likely to be around areas to do with fairness (i.e. antitrust policies which could see some e-commerce players who have scale advantage to face scrutiny). The policy direction has been hinted towards these regulatory changes for some time now so many of the leading companies are complying.
Should investors in Chinese equities consider political aspects more strongly going forward?
Whilst we can’t predict the details of every policy move (such as the recent one around education), it is important to keep in mind the historical context and the longer-term goals that have been laid out. China has clear priorities around economic growth, including doubling its GDP per capita (once again) by 2035 - a vibrant and healthy private sector is essential to achieving this aim. Priorities around innovation are also clearly rising - many of the companies in the sectors we are talking about are not only big employers and drivers of growth, but also drivers of innovation. Also, China has made no secret about its goals around developing its capital markets and internationalising the RMB. Clearly, the creation and evolution of a stable investment environment -for both domestic and foreign investors- has to play a part.
The latest regulatory changes reiterate our view that policy direction and implementation does need to be monitored when investing in China.
Whilst we can’t predict the details of every policy move (such as the recent one around education), it is important to keep in mind the historical context and the longer-term goals that have been laid out. China has clear priorities around economic growth, including doubling its GDP per capita (once again) by 2035 - a vibrant and healthy private sector is essential to achieving this aim. Priorities around innovation are also clearly rising - many of the companies in the sectors we are talking about are not only big employers and drivers of growth, but also drivers of innovation. Also, China has made no secret about its goals around developing its capital markets and internationalising the RMB. Clearly, the creation and evolution of a stable investment environment -for both domestic and foreign investors- has to play a part.
The latest regulatory changes reiterate our view that policy direction and implementation does need to be monitored when investing in China.
Are you worried that innovative companies may leave China due to the stricter regulation?
No, it’s highly unlikely because innovation is a key focus for the Chinese government. It has been a key priority for many sectors and this development is unlikely to be halted.
No, it’s highly unlikely because innovation is a key focus for the Chinese government. It has been a key priority for many sectors and this development is unlikely to be halted.
In China, the PPI has been rising strongly. (June plus 9%, July plus 8,8 %). Is there a danger this will feed through to the CPI, which has been very low? And if yes, will it affect consumption?
The CPI basket is primarily comprised of food and notably pork prices, which are not increasing. The household savings rate rose from low 30% to 37% last year so with a relatively tight employment market and this high savings rate, the consumption story and pent up demand is playing out.
Specific Sectors
What makes you optimistic despite new regulations for Chinese tech-companies such as Tencent?
As I mentioned, government regulation is a constant in China - any investor must accept and incorporate this into his/her risk/reward framework. Many policy initiatives are still evolving and certainly can cause uncertainties which is why it is key for us, at Fidelity, to incorporate this factor into our assessment of the long term business prospects, along with how corporate management teams and their business models are positioned to navigate these changing policies.
Tencent, however, is THE social network in China. It has carefully nurtured and enriched user experience which has led them to grow users and time spent. As China’s internet user growth slows down, Tencent’s enviable user base creates an extremely deep moat for their company. Further, monetization continues to be a key theme for China’s internet industry given the slowdown in user growth. Tencent, in our view, remains very well positioned in terms of monetization potential because of its highly sticky user base and strong ecosystem.
Having said all this, regulatory risks have yet to peak out in the internet space; key areas to closely monitor include data security laws, antitrust investigations, worker’s benefits and content regulations. Additionally, whilst valuations have become very attractive for some names, we need to also consider that sentiment will likely remain weak over the short to medium term.
As I mentioned, government regulation is a constant in China - any investor must accept and incorporate this into his/her risk/reward framework. Many policy initiatives are still evolving and certainly can cause uncertainties which is why it is key for us, at Fidelity, to incorporate this factor into our assessment of the long term business prospects, along with how corporate management teams and their business models are positioned to navigate these changing policies.
Tencent, however, is THE social network in China. It has carefully nurtured and enriched user experience which has led them to grow users and time spent. As China’s internet user growth slows down, Tencent’s enviable user base creates an extremely deep moat for their company. Further, monetization continues to be a key theme for China’s internet industry given the slowdown in user growth. Tencent, in our view, remains very well positioned in terms of monetization potential because of its highly sticky user base and strong ecosystem.
Having said all this, regulatory risks have yet to peak out in the internet space; key areas to closely monitor include data security laws, antitrust investigations, worker’s benefits and content regulations. Additionally, whilst valuations have become very attractive for some names, we need to also consider that sentiment will likely remain weak over the short to medium term.
In the Spring of 2021, the 14th 5-Year plan was introduced by the Chinese government. It focuses on developing the technology sector in China as well as domestic consumption. Has this opened new opportunities for Fidelity funds and where?
The Government’s focus on innovation and a robust domestic economy (driven by the consumption of goods and services) remains a key theme for our strategies. This focus isn’t anything new but instead a continuation of what we have seen for many, many years. Many stocks in these segments (i.e. biotech, e-commerce names, etc.) were favored by investors last year and even in 2019. With the correction we have seen this year though, many of these companies are now trading at more attractive multiples. In fact, in terms of valuations we are currently seeing many companies in the technology space trading at historical low valuations, and at significant discounts to global peers. We acknowledge that there is potential for business models to change and we are, accordingly, adjusting down our expectations around monetization levels in certain companies. Having said this, investment is all about risk-reward and for many names, this is looking favorable after recent moves.
Your Chinese mutual funds are also invested in the consumer sector. What are your views on this?
Not only we are seeing favorable fundamentals to such consumer companies, but support is coming via government policies plus the changes and evolution of the Chinese consumer. These days, it’s no longer just what the consumer buys but why and how they buy their goods and services. Consequently, not only are we seeing a continued trend towards buying goods online, but we are also seeing, with urbanization and higher incomes, the premiumization story play out plus local brands gaining market share.
Not only we are seeing favorable fundamentals to such consumer companies, but support is coming via government policies plus the changes and evolution of the Chinese consumer. These days, it’s no longer just what the consumer buys but why and how they buy their goods and services. Consequently, not only are we seeing a continued trend towards buying goods online, but we are also seeing, with urbanization and higher incomes, the premiumization story play out plus local brands gaining market share.
What about the health sector that you overweight in some of your funds?
Big opportunities lie ahead in China for medical innovation and upgrades. On the demand side you have a big domestic market with ample room to grow -as the 2nd biggest market globally, it is too big to ignore-. The market structure changes from generic drugs to innovation drugs and from low-end medical devices to high-end medical devices, which brings a huge commercial potential for innovative healthcare products.
Key drivers behind this include aging population, increasing disposable income and huge non-met medical needs. As the Chinese economy keeps on growing and Chinese aging population continues to pursue better quality of life, we think that we are at the start of a golden era to capture the upgrade of medical needs in China – a long-term theme.
When it comes to the supply side, China is targeting the broader global market as it has emerged as a global innovation hub. With an explosive number of emerging biotech companies, China is fast to climb up the value chain, catching up quickly in new technology/new targets vs. global peers.
Key drivers behind this include ample capital support, sufficient government support, rich talent pool (returnees), cost advantage & better productivity, etc. We believe that these are unlikely to reverse. We are at the start of a golden era to capture the innovation wave in the Chinese healthcare space - a gain, a long-term theme.
In which sectors are you finding less value in and why?
It is currently the earnings season in China, so we are looking for opportunities, especially where valuations are looking attractive. With a focus on long-term growth themes such as innovation and the rising Chinese consumer, we tend to find less interesting opportunities in more of the old China segments where alpha generation isn’t as attractive.
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